Let us deal with a case study. Under an ESOP, 'Company ABC' gives shares/warrants to its employees through the mechanism of an employee Welfare Trust.

The warrants entitle the employees to acquire shares at an exercise price of Rs. 100 only, even though the market price of the company's scrip is much higher.

As per the ESOP agreement there is a five-year lock in the period. If the employee chooses to leave the organization within this period, the warrants or the shares acquired on exercise of the warrants have to be surrendered back to the trust.

Two features about this plan need specific attention:

• The shares acquired on exercise of the warrants have a lock period of 5 years. Consequently even if the market price of the shares is higher than the exercise price, the employees are not allowed to encash on the difference.
• If during the lock-in period, the employee were to leave the organization he would have to transfer back the shares/warrants to the Employers Welfare Trust at the exercise price only. The employee would thus not be able to gain anything.

It can be argued that even if the warrants granted had a perquisite value, this value was contingent and not immediately realizable by the employees.

One of the basic tenets of taxation under the Income Tax (I-T) Act, 1961, is that income should have been 'accrued' or 'received'. Here, income was not received, but did it accrue in the hands of the employees? Let us analyze this issue.

It has been held by the Bombay High Court in the case of CIT v. Associated Cement Companies (48 ITR 1), that profit can be said to have accrued only when it becomes due and realizable. Mere claim to profits is not sufficient for the purpose of fastening tax liability.

Furthermore, the Supreme Court in the case of CIT v. Shoorji Vallabhdas and Co. (46 ITR 144) has held that where no income can be said to have resulted at all, there would obviously be neither accrual nor receipt of income. The apex court once again in the case of Godhra Electricity Company v. CIT (255 ITR 146) has reiterated that income must be actually receivable to be taxable. There are numerous other decisions which have clarified the concept of accruals.

Even in the context of taxability of a perquisite, it is essential that the employee must have a vested-right over the perquisite value in order to attract tax liability. In the case of L.W.Russell v. CIT (44 ITR 816)(Ker) later affirmed by the Supreme Court (53 ITR 91), it was held that where the company set-up a trust to grant pension or other deferred benefit program to the employees, there was no taxability as the employees did not have any vested right but merely a contingent right.

Similar in cases where the companies paid premiums under staff group insurance schemes or personal accident policies, it has been held that this does not give rise to any perquisite value, as employees have no vested right in the policies.

Reference may be drawn to P.Newcome v. CIT(45 ITR 52)(KER); CIT v. Lala Shri Dhar (84 ITR 192)(Del); CIT v. Vinay Bharat Ram (129 ITR 128)(Del); and CIT v. M.N.Nadkarni (161 ITR 544)(Bom) to name a few.

Thus in the case of 'Company ABC', there would be no taxability in the hands of employees when the warrants are granted or exercised by the employees. However, perquisite arises on vesting. But even in relation to the years prior to amendment of the I-T Act, it can be argued that the perquisite does not arise at the time of the grant.

The provisions of the I-T Act now provide that the perquisite arises in the year of exercise of the option. It is the difference between the fair market value as on the date of exercise and the option price. The amendments made and the concept of vested right v contingent right should help the companies to argue out their cases well before the tax authorities.